Writing on economics, ethics and philosophy

Archive

Monthly Archives: December 2012

HAVING recently seen the insides of more hospitals than I wanted, and having accordingly had bills from more medical specialists than I dreamed existed, I have a more intimate awareness of the Medigap than I had when I wrote my April 20 column on the subject. Hence these reflections on three related problems.

First, I have an unhappy impression that some of the specialists were unnecessary, and that some of the things the necessary ones charged for were unnecessary. A couple seemed to drop around for two or three minutes of bed side chitchat long after the diagnosis had been made and their specialty’s noninvolvement confirmed.

One of the latter, a nice fellow with an impressive beard, sent me a bill for 12 such visits at $65 a pop. Medicare will ultimately pay somewhat less than one-half of that, and a group policy I have will probably pick up 80 per cent of the balance; so I’m not hurting too badly. But every medical expense, whether legitimate or not, goes to swell the national medical bill and thus the medical insurance bill. Medicare then raises its rates or reduces its benefits, and the private insurers do the same.

Now, my impression that this fellow with the beard was riding the gravy train is only an impression. I don’t know, and I have no satisfactory way of finding out. Besides, when I’m a patient I want to have everything possible going for me. So I’m not going to inquire whether bills are padded, and I’m not going to shop around (as the Reagan Administration thinks I should) to get the cheapest rates.

You might think my GP blameworthy for sending in all those specialists. Yet put yourself in his shoes. Suppose he doesn’t call in all the specialists and suppose they don’t order all the blood tests and X-rays and CAT scans and MRIs. Then suppose I wind up with a serious ailment that might have been avoided. As I keep telling you, I’m a mild-mannered man and I’d probably not sue, but plenty of others would. So to guard against a malpractice suit, the GP orders every specialist in sight. Of course, peer review might be able to do something about this problem, and for all I know it does; but I’m sure it’s not easy.

Insurance companies keep trying to get legislatures to limit the amount of damages that can be collected, or to outlaw claims for pain and suffering. This seems to me an unreasonable solution. Malpractice does occur, and accidents do occur. Should I lose the use of my right hand because of an incompetent or accidental slip of a surgeon’s knife, I’d not be “made whole,” as the lawyers say, by a free night in the hospital (less legal fees). If the doctors can’t afford high malpractice premiums, and the insurance companies can’t afford to lower them, I can’t see any course short of turning the whole thing over to the government. As Charles O. Gregory argued in a wise and witty book entitled Torts and Retorts, all sorts of personal injury claims (torts) should be the responsibility of the State.

A leading theme in the history of Western law has been the gradual transfer to the State of rights and duties that in more primitive civilizations were private. In ancient Greece, triremes were built not at State expense but at the expense of rich men chosen by lot for the honor. In late medieval Italy, all families of any consequence maintained private militia, like the followers of the Montagues and the Capulets, and competed in building lofty military towers that would enable them to overawe their neighbors. San Gimignano, a town of no great size, had 70 such towers, 14 of which still stand. (A civilizing step was the passage of a municipal law-a zoning ordinance- prohibiting towers beyond a certain height.) For centuries, the detection and punishment of crime was solely the obligation of the injured. Fairly late, the impersonal judgment of God was rendered via trial by battle and trial by ordeal. Secular public enforcement of criminal law is a relatively new idea.

In the same way, health care is gradually shifting its ground. The notion of fee for service is already being compromised by the movement to shame doctors into accepting approved fees. It’s not too much to hope that we may eventually have the sense to adopt the better European systems.

A step in this direction has been taken by Massachusetts. Cynics say it is a calculated maneuver in Governor Michael S. Dukakis‘ play for the Democratic Presidential nomination. Giving the Duke the benefit of the doubt, I still think his scheme is an example of what Samuel Johnson said about good intentions and the road to hell.

There are close to 6 million residents of Massachusetts and almost 700,000 of them have no health insurance. I must admit I’m astonished that so few are not covered. About two-thirds of the uninsured are employed or are dependents of people who are employed. The Governor proposes to narrow the gap by requiring all employers to insure their employees, with the state picking up the relatively small balance. Clearly what makes the scheme attractive is Massachusetts’ present unemployment rate, said to be less than 2 per cent, since the drain on the Commonwealth fisc won’t require dramatically higher taxes. Before the days of high-tech, when Massachusetts’ unemployment rate was one of the highest in the country, the scheme wouldn’t have seemed so painless.

That brings us to the second problem. Whatever the condition of business, universal employer-financed health insurance has a damping effect on employment. Once additional employees cost you several hundred dollars apiece beyond their pay, you’re not so cavalier about hiring them. (Social Security taxes, right now, work to discourage employers in this way; they’re also heavily regressive on employees.)

Just because we’ve stumbled along this half century with a far from perfect Social Security system doesn’t mean that more of the same won’t hurt us. In The Next Left Michael Harrington argues persuasively that piling payroll taxes on payroll taxes was largely responsible for the high unemployment that contributed to the failure of Socialist President Francois Mitterrand‘s program in France. It could happen here.

Aside from Workmen’s Compensation, medical insurance has no special connection with employment. In a more civilized nation, all such protection would be a national responsibility, met out of the general revenue without the intervention of insurance companies, private or public. The tax bill might then seem higher, but the drain on the common wealth would be very much less, and the salutary effect on the general welfare would be very much greater.

For this reason I’m not passionately interested in HR 2470, the bill the House has passed limiting some catastrophic medical expenses to $2,000 a year. And speaking personally, although our medical bills will be many times $2,000 this year, HR 2470 will not, as I understand it, benefit us in the slightest. The insurance company that wrote the group policy I’ve mentioned will get all the benefit, and we will have to pay maybe $1,160 a year in increased Medicare premiums. The insurance companies that will be hit are the TV bandits I described here last April-if their bemused subscribers have the sense to drop them as utterly useless as well as scandalously expensive.

Those committed to laissez-faire insurance complain that HR 2470 provides for a sliding scale of premiums. Since this tops out at an Adjusted Gross Income of $14,166, my objection is not that it is progressive, but that it is not progressive enough. It is not reasonable for anyone with an AGI of$14,166 to be put in the same class with David Rockefeller, or even with me.

THE THIRD medical problem is the hundreds of thousands soon to be tens of millions- of senior citizens who can no longer take care of themselves. In the good old days, before there were such things as senior citizens, the old folks moved in with the young folks, or possibly had a spinster daughter move in with them. In either case, the elders were able to give their adult offspring the benefit of their long accumulated wisdom, driving the offspring to spring up the wall. In many a home, something approaching The Tragedy of King Learwas re-enacted. Yet both generations took some comfort in the fact that the elders were not a public charge. Where, for lack of family support, they were the public poor house took over.

All this has changed, for reasons we’re all familiar with: Family ties are looser today; individual pride is stronger; the expected life span is very much longer; bottom-line-conscious employers are quick to replace high-priced and slowed down old hands with eager beginners; and medical research has rendered many diseases incapacitating rather than killing.

These changes lead to the matter of nursing homes and how to pay for them. They are not paid for by Medicare or by most commercial health insurance. They are paid for by Medicaid, but only at the expense of near-pauperization. The rules are complicated, and complicated revisions are daily suggested; yet it remains at best a disheartening and dishonoring process, especially for the middle class that has worked hard for independence. What’s to do about it?

Actually a simple solution suggests itself. Instead of forcing pauperization before entry into a nursing home, apply the force at the end. That is, if it is reasonable for the government to exact as full payment as possible for nursing home care, let it do so from the patients’ estates after death, not from their reserves.

They would thus be able to retain the hope, however slim, of being able one day to take care of themselves again, outside the confines of the nursing home. Moreover, they would be spared the shame of pauperizing both themselves and their spouses, or the alternative heart-wrench of unwanted divorce in order to protect the independence of the non-institutionalized partner.

Obviously it would be difficult to devise regulations that would forestall the temptation to diddle the government in one way or another. But the same difficulty obtains under the present system. Obviously, too, it would cost the government something to have to wait for its money. On the other hand, the money, when the government finally got it, would tend to be greater, for there would be no need for most of the exceptions that now limit Medicaid’s claim on a patient’s means.

Finally, some will object that my plan would deprive offspring of their rightful inheritance. To them I reply: (1) The heirs of patients pauperized as a condition of Medicaid inherit little or nothing as it is; and (2) I’m not one to do battle for the right of inheritance, anyhow. In fact, I join economists as various as Hayek and Keynes in thinking the right might well be abolished. But that is another question.

The New Leader

Share this:

Like this:

ONE LISTENS with astonishment to the explanations of the Great Crash of 1987. With unprecedented unanimity, pundits and brokers and bankers and public officials call the budget deficit and the foreign trade deficit to blame.

In his post-crash press conference, President Reagan seemed not to understand. He was being pushed into what the press called a summit conference with Congressional leaders to see about reducing the budget deficit, but his heart plainly wasn’t in it. Look, he protested, the budget has been Gramm-Rudmaning down and will go down some more, even without a conference. He couldn’t see what is so bad about that trend, although he was ready to blame the Democrats for anything anyone happened to think bad about it.

It’s not hard to share the President’s bewilderment. If the budget deficit is a problem, it is in fact being reduced. A few hardliners may be upset that the reductions are not greater and faster; yet most people (including Ronald Reagan) have absorbed enough from Keynes (whom the President gracelessly and ignorantly disparaged) to know that doing too much too fast with the deficit would be a pretty sure prescription for a recession. Keynes himself might well have thought the reductions an utter mistake at this time. But he is dead (as we all are in the long run), and what is actually being done is what the pundits say Wall Street wants. If Wall Street is really upset by the deficit, it should have broken two years ago, when the deficit was higher, or five years ago, when the deficits (and the market itself) started their dramatic climb.

No, the deficit story is a fairy tale. It is implausible on its face, and its implausibility can readily be tested. We had a pretty good market crash in 1929. What happened then? Well, one thing is sure: The 1929 crash wasn’t caused by a budget deficit, for the budget was in surplus that year to the tune of $700 million, which was a lot of money back then. Either the crashes of 1929 and 1987 are totally different breeds of animal, or deficits had nothing to do with either of them.

The two crashes did, without question, have one thing in common. Both were preceded by prolonged and steep run-ups of the stock markets. That in itself is no surprise, since you have to have attained a certain height to be able to make an attention-getting fall. But what it signifies is that both climbs were speculative: Business didn’t improve all that much. Though in both years all persons of prominence assured us that the economy was fundamentally sound (there seem to be no other words to express this meaningless thought), in neither year was there a justification for the heights the market reached.

Speculation, however, doesn’t need a justification; it merely needs an occasion. The necessary occasion is a very simple one: Some people have to have more money than they know what to do with. Literally.

Now, it is practically impossible to spend a million a year on living well (although some 57 professional baseball players are having a go at it), and it is perfectly possible to be pretty comfortable, even in a high-priced city like New York, on as little as a hundred thousand. You can, of course, spend pots of money collecting lead soldiers or used postage stamps or post impressionist masters. The trouble with such collections is that, even at a moderate rate of inflation, they increase in value very rapidly and so add to rather than deplete your wealth. So lots of people-and not merely ball players have lots of money.

The supply-side theory, to which the President pledged continued devotion the other night, contemplates that the rich, thwarted in their struggle to consume their income, will invest it. But when 20 per cent or more of the economy’s productive capacity is lying unused, the possibilities of prudent new investment are severely limited. What to do? Nothing for it but to take a flyer in the market. At the same time, the rich of the rest of the world have the same problem-and the same solution. Add to all this the mutual funds, the pension plans, the educational and charitable endowments, the insurance reserves, and the unabashed speculations, and you have a lot of money chasing a limited number of shares of stock.

Ingenious men have worked very hard to increase the number and kinds of paper to buy and sell. Two ways have especially recommended themselves: the development of the stock futures markets, and the computerization of Wall Street. The first created new products (as the brokers call them) out of nothing but the eagerness to speculate; the second, by enabling an increased velocity of trading, increased the opportunities to speculate, just as an increase in the velocity of money in effect increases the money supply.

There was also a partially contrary movement. Takeovers and buyouts, which generally substituted debt for equity, reduced the number of shares of some stocks available for speculation while simultaneously greatly enhancing the taste for speculating.

THE MOST elementary fact about a bull market is that it absolutely and unceasingly depends on sucking more money into it. If there are 100 shares of stock, and $100 available for investment, the price of each share will fluctuate narrowly around a dollar, no matter what incantations are uttered by market analysts and government officials. If the number of available shares is reduced, or the number of available dollars increased, the price will rise proportionately. But all who anticipate a further increase in available funds will become more eager in their bids, in the expectation of quickly and profitably selling what they buy to the holders of the new money. Thus Holland’s Tulipmania was sustained, and thus the Great Bull Market of the ’20s, and thus the Reagan-Thatcher-Nakasone market that has now crashed.

Because one way or another the number of pieces of paper to speculate in has greatly increased, the number of dollars to sustain the recent bull market had to be increased still more, and this has been done in two ways: the shift of trust and endowment funds out of the bond market and into the stock market, and the supply-side tax cuts for the wealthy. The former was substantially effected a couple of years ago, and the latter has gone about as far as it can go with the new tax law’s reduction of the top rate to 28 per cent. There is still a fantastic amount of money around, but it is no longer being increased rapidly. The kissing had to stop.

The trade deficit is said to have joined with the budget deficit in scaring foreigners out of our market. This explanation of the crash overlooks what is ordinarily insisted on: the global interdependence of financial markets. It wasn’t Wall Street alone that laid an egg. Eggs were laid in Tokyo and Hong Kong and Sydney and London before the New York market opened on Black Monday. You might say that all over the world bull markets that had known no boundaries were suddenly fenced in.

Just as the reason for the crash is grievously misunderstood, the policies proposed for dealing with it are grievously misconceived. Since what happened was caused by a large number of people having more money than they knew what to do with, it follows that it is counterproductive to resist taxing some of that money and applying it to public purposes, not excluding deficit reduction. The supply-side tax cuts were a disaster. Since the wealthy couldn’t find enough new productive investments for their surplus funds, it follows that there hasn’t been enough effectual demand (as Adam Smith would have said) to keep our existing productive capacity busy; so the enthusiasm devoted to union busting, entitlement shaving, welfare restricting, and real-wage reducing-all of which reduce effectual demand-has been disastrously misdirected.

Our pundits seem able to behold the mote in German and Japanese eyes but not to consider the beam that is in ours. If the world economy would be strengthened by increased consumption in those lands (and it would), it can scarcely make sense to decrease consumption in ours. Over the past 15 years the income share of the poorest 20 per cent of our families- those who have to spend their incomes-has fallen 10.8 per cent. An economy that reduces its aggregate demand in that way-and seems determined to do more-is not fundamentally sound.

The New Leader

Share this:

Like this:

THE CENSUS BUREAU has finally released its estimates of the 1986 median family income, the numbers of people living in poverty, and the distribution of income among the rich, the poor and the middle class. The news is not the figures: They merely confirm the impression everyone has had. Rather, it is the Bureau’s acknowledging for the first time that “there has been an increase in inequality in the United States during the last decade and a half”-or from Richard M. Nixon through Ronald Reagan.

It is by no means easy to know how to go about measuring inequality. Lars Osberg has written a solid 300-page book on the subject, Economic Inequality in the United States, that is a good place to begin if you want to understand the complications. For my part, I share Disraeli‘s view that there are “lies, damned lies, and statistics.” So I’ll take what the Census Bureau says on trust (or distrust) and simply note that its figures assume the rich, the middle and the poor are fixed percentages of the population, instead of classes with definable characteristics to which variable numbers of people belong. On this basis we always have the three groups with us, and in the same proportions.

Putting to one side the probability that if you want to understand how the economy distributes its benefits wealth[1] is a better index than income[2], I suggest that the customary method of presenting the statistics understates the shocking and dysfunctional economic inequality in the United States. It is bad enough that from 1970 to 1986, as the Census Bureau reports it, the richest fifth of American families increased its share of the national income from 43.3 per cent to 46.1 per cent, while the poorest fifth saw its share decline from 4.1 per cent to 3.8 per cent, and the share of the middle three fifths dropped from 52.7 per cent to 50.2 per cent. My guess is that figures for the same years showing how many families had incomes over, say $500,000 (in constant dollars) and under $10,000 would give a better idea of our increasingly polarized income distribution.

That shifts in distribution are occurring at all has a bearing on a long-running debate in economic theory. A typical statement of one side of the debate is Pareto’s Law, promulgated by Vilfredo Pareto in 1896, and not to be confused with his fashionable but fuzzy notion that goes by the clumsy name of Pareto Optimality. In an impressive array of societies, Pareto estimated as best he could, given the practical nonexistence of reliable data, the arithmetical mean of incomes. These means did not come in the center, as they would have if the distribution followed a standard bell curve. Furthermore, the curve on the high side of a mean was radically different from that on the low side, because there was no top limit to possible income, but everyone below a bottom limit died of starvation, reducing the curve to a straight line at that point.

Pareto’s supposed law is frequently misrepresented to assert that no change is possible in income distribution. Actually, he allowed that change did occur on the low side of the mean. It was, after all, obvious that fewer people starved to death in 19th-century Europe than had done so previously. What happened on the low side of the mean didn’t interest him, though. He was fascinated by the consistent pattern he claimed to see on the high side and by the conclusion he drew from it, namely that progress for the lower orders depended on progress for the top. Efforts at redistribution, in his view, were doomed to failure and could only make it worse for everyone.

Unlike more naive knee-jerk conservatives, Pareto did not claim that the same people would invariably be on the high side. He hoped there would be a lot of movement up and down, in the expectation that this would permit Darwinian laws (which he obviously misunderstood) to improve the species. Nevertheless, his alleged law provides alleged justification for the trickle-down theory of political economy.

Pareto himself recognized, at least in principle, that his law was only empirical. It depended on the facts he so laboriously collected and was inevitably at the mercy of contradictory facts, such as those just released by the Census Bureau. Empirical observations are elevated to the status of laws only if reasoned explanations can be adduced for them. In the present instance, maldistribution of talent or effort has been proposed as the explanation for the maldistribution of economic rewards: If you’re so smart, how come you’re not rich? But the sole evidence for the distribution of talent or effort is the distribution of rewards. The argument chases its tail.

If there is no natural law of income distribution, then human policies can have an impact, and it is no longer rational to argue that prosperity depends on making the rich richer. Indeed, it becomes steadily clearer that a more egalitarian distribution of income would produce greater prosperity. The issue, however, is usually posed in terms of psychological incentives. The economy springs ahead, we are told, because certain people are good at getting things done, and these people need financial incentives.

This has never been good psychology. On the one hand, the real can-do guys, like a Marine lieutenant colonel we have recently heard of, are must-do guys. They get their kicks from doing, not from accumulating, and the problem is to calm them down, not stir them up. On the other hand, you have to use either a carrot or a stick to get most people to do the humdrum jobs and the unpleasant jobs-that is to say, most of the jobs. Carrots are obviously more humane than sticks (I like carrots). Any economy or any company that beats its people with sticks is to that extent inhumane. It demeans itself.

There is also a less pressing reason for a more egalitarian distribution. Keynes wrote a great book to elucidate it. A prosperous economy depends on the society’s propensity to consume, and the propensity to consume depends on the ability to consume, which depends on the ability to pay the bills. “Experience suggests,” Keynes said, “that in existing conditions saving by institutions and through sinking funds is more than adequate, and that measures for the redistribution of incomes in a way likely to raise the propensity to consume may prove positively favorable to the growth of capital.”

THE CENSUS BUREAU figures show that we are going in the opposite direction, and they are ominous from the point of view of our society as well as from that of our economy. “Wealth,” Plato wrote in The Republic, “is the parent of luxury and indolence, and poverty of meanness and viciousness, and both of discontent.” Aristotle saw that “those who have too much of the goods of fortune … are neither willing nor able to submit to authority …. On the other hand, the very poor … are too degraded…. Thus arises a polis, not of freemen, but of masters and slaves.” These observations are obvious enough. Surprisingly, it remained for Rousseau to give the argument a subtle shift: “It is on the middle class alone that the whole force of the laws is exerted; the laws are equally powerless against the treasures of the rich and the penury of the poor.”

In any stable society the middle class is, for all practical purposes, the society. The middle class feels the force of the laws because it has a stake in the laws in things as they are, or at least in the direction things are taking. The upper class feels itself exclusive, the lower class excluded; they are at best indifferent, at worst hostile.

Since super-rich individuals and infra-poor individuals can be law abiding, social class as understood by Rousseau and me is not quite the same as economic class. Yet the two kinds, though they are not congruent, do very much converge; consequently, what the Census Bureau sees happening to what it calls the middle class (the middle 60 per cent of the population) is worth attending to.

The American middle class is slipping economically. Moreover, it is likely that many of the 38.2 million families so classified might more accurately be grouped among the working poor. The average income of those above the middle 60 per cent is $126,415 that of those below is $10,142 (or lower than the official poverty level of $11,203). These figures are a long way from fully disclosing the range of incomes, but they do suggest fertile fields for alienation at both extremes. What can happen here-what is happening here-is not alienation in the sense of allegiance to a foreign power, but alienation in the sense of no allegiance whatever.

To allege that President Reagan has consciously aimed at the erosion of the middle class would be easy, but it would be wrong. The conscious aim has been to make the rich richer on the Paretan theory that the rest of the economy will be dragged upward, too. I hasten to protest that I’m not suggesting the President ever heard of Pareto, let alone read him; it’s just a case of great minds running in the same channel. And not only Reagan’s mind, but Margaret Thatcher‘s and Jacques Chirac‘s and Helmut Kohl‘s, and Yasuhiro Nakasone‘s, and those of most of the leaders of the Third World and of most of the people running the IMF, not to mention every investment banker you ever heard declaiming about the bankruptcy of Social Security. We are faced with something more than an aberration of American politics.

Even if the Democrats manage to avoid self-destruction, and even if they manage to awake, like Rip Van Winkle, from their 20-years dream of middle-of- the-roadism, they will still have to struggle to protect our society from the conservative crazies of the rest of the world. For regardless of what we do at home, these crazies will continue to enrich their rich, who will continue to want to speculate on our markets, which will again suck up and ultimately destroy whatever surpluses we create.

Share this:

Like this:

ANOTHER BUDGET deadline has come and gone and that old devil deficit is still there. What can we do about it? First, we had better consider briefly what would happen if Gramm-Rudman- Hollings were successful in getting the annual deficit down to zero. For we’d have a crashing depression, that’s what would happen. Whether the miracle were achieved by reducing military expenditures or by cutting off the poor or by raising taxes or by all three, somehow $160 billion (more or less) would be abstracted from the economy.

Actually, “abstracted” is the wrong word. The $160 billion would not be taken from the spendthrift government and put in your thrifty pocket to be used in a more propitious time. No, all that lovely money would not exist. Moreover, the possibility of its existence would be gone forever, and with it the goods and services the money might have bought, plus the goods and services that might have been bought by those who would have earned money by producing the first lot, and so on ad infinitum. R.F. Kahn‘s multiplier works both ways.

Or look at it this way: One hundred and sixty billion dollars is about 4 per cent of our gross national product. The average fall in GNP for depressions since World War I has been about 6 per cent. The possibility is more ominous when you consider the unemployment rate. In 1929, the rate was 3.2 per cent. Today, it is officially stated to be 5.9 per cent-and this counts part timers as fully employed, and doesn’t count at all those who are too discouraged to look for work. In other words, we have a head start on any depression we decide to bring about.

Mention of unemployment reminds us of the real point: The vice of depression is not the loss of potential goods and services but the loss of jobs and self-respect. No one can spend much time in the labyrinths of a shopping mall without concluding that we already have more goods and (perhaps) services than we-literally-know what to do with. Our basest beggars are in the poorest thing superfluous. Personal dignity and self-respect depend on the right to contribute to the common wealth. Even without a depression too many of us are denied that right. We are all demeaned by that denial.

Does this mean we are doomed to run deficits forever? Won’t all that debt bring double-digit inflation back again? And isn’t it irresponsible to pass on to our children the consequences of our fecklessness?

When you look at the record, you wonder how these staples of campaign oratory and editorial punditry get taken seriously. In 1980, the deficit was $73.8 billion (or 2.7 percent of GNP), and the gross Federal debt was $914.3 billion (or 33.47 per cent of GNP); the inflation rate was 12.4 per cent. Last year the deficit was $220.7 billion (or 5.2 per cent of GNP), and the gross Federal debt was $2,132.9 billion (or 50.68 per cent of GNP); the inflation rate was 1.1 per cent. There is no way these figures can be tortured to support the claim that a deficit causes inflation (see editor’s chart below).

Well, the states balance their budgets, so why can’t the Federal government? Of course, it could-provided we accepted one of two outcomes: Either private businesses and private individuals would have to increase their indebtedness to match the Federal decline, or we would have to have that depression. The reason for this is simple: The flip side of debt is credit, and credit is money. (If you want to be fussy: not all credit is money, but all money is credit.) Without debt, no credit; without credit, no money; without money, no business. That’s the way the capitalist system works. That’s the golden-egg-laying goose that myopic conservatives want to kill.

But what about our children and theirs? As Keynes observed, it is no favor to our children to neglect our natural and civic and domestic environments and thus save our children from the perils of indebtedness in their adulthood at the expense of forcing them to spend their childhood in squalor.

The foregoing merely suggests ways in which the anti-indebtedness argument is false. It does not claim that the present is the best of all possible worlds, that the level of our current deficit is exactly right, that we might not better buy different things with our money, or that we might not do better by financing the deficit differently.

Let it be said at once that the appropriate level of the deficit is a matter of trial and error. In spite of the most sophisticated programs run on the most powerful computers, Pandora’s box remains closed to us. Consequently, to say that we can fine tune the economy is an exaggeration. It is, however, a fact that we have, in the record of the past 40 years, proof that some kind of tuning can have significant results.

This brings us to the probability that at some time-perhaps tomorrow, perhaps the day after-we may want to tinker with the new tax law we hailed so proudly only yesterday. We may, in any case, want to remind ourselves that taxation is not necessarily for revenue only. Attending a debate in the Academy of Laputa[1], Lemuel Gulliver was struck by a proposal “to tax those qualities of body and mind for which men chiefly value themselves …. The highest tax was upon men who are the greatest favorites of the other sex; and the assessments according to the number and nature of the favors they have received, for which they are allowed to be their own vouchers …. But, as to honor, justice, wisdom and learning, they should not be taxed at all; because they are qualifications of so singular a kind that no man will allow them in his neighbor, or value them in himself.”

That excellently bitter proposal is not explored in the 291-pageDescription of Possible Options to Increase Revenuesrecently prepared by the staff of the Joint Committee on Taxation with the staff of the Committee on Ways and Means. Part I examines what it discreetly calls” Revenue Areas [it would be lese majeste to call them tax increases] Addressed by the President’s 1988 Budget Proposals.” Adopting all of them would increase 1988 revenues by about $3.7 billion-scarcely noticeable in the shadow of a $160 billion deficit. Part II, taking up the document’s remaining 257 pages, examines “Other Possible Revenue Options,” most, if not all, having been suggested by members of the Committee on Ways and Means. These naturally reflect the various members’ interests and capabilities, and many are nutty (as are some of the President’s), while others are politically impossible, at least for now. Though it is likely that, as a whole, they exceed the magic $160 billion goal, there is no point in adding them up because many of them would work at cross purposes, and because nowhere in the pamphlet is there a discussion of the leading weakness of the 1986 tax law.

This weakness is the almost complete abandonment of progressivity. The great strength in the new law is that the grossest shelters were blown down. But, as is well told in Showdown at Gucci Gulchby Jeffrey H. Birnbaum and Alan S. Murray, the Senate Finance Committee grudgingly accepted the strength in order to achieve the weakness.

The attack on progressivity has been going on for several years. It was not so long ago that the top bracket in the personal income tax was 85 per cent. Then it was reduced to 50 per cent on “earned income.” Then to 50 per cent on all income, except for capital gains, which were taxed up to 35 per cent. Then capital gains were dropped back to 20 per cent. And now the top rate is 28 per cent across the board, with a complicated proviso that need not be of concern to you unless your taxable income exceeds $200,000. (The proviso, allowing for certain deductions at the lowest rather than at the highest rate, was one of the few good ideas of the original Bradley-Gephardt proposal. See “A Cautionary Tale of Tax Reform,” NL, January 27,1984.)

HOPE OF CHANGING the tax law’s rate of progressivity was abandoned by everyone who entered the Congressional conference rooms. It was insisted from the start-by Bradley-Gephardt in 1983 as well as by Reagan- Regan in 1986- that a reformed tax law would be revenue neutral. This shibboleth meant not merely that the total revenue raised under the new law would be the same as that under the old, but also that the various quintiles of income recipients would pay the same proportions of the total tax under both laws. An exception was that certain of the poorest of the poor, who had been added to the rolls in the reactionary surge of 1981-82, would now be dropped again.

The new law is certainly better than the old in that whatever is unreasonable or unjust in it is plainly stated rather than shoddily sheltered. But that is not to say it is more reasonable or just. It may, in fact, lead to greater injustice. It is probable that throughout the corporate world executives will demonstrate an increased eagerness for high salaries because they will be able to keep a higher proportion of them. It is probable, too, that the kind of investment banking that leads to raids and takeovers and greenmail will be stimulated, and that so will the securities and commodities and futures markets. It is even probable that the changes in the corporation tax will encourage many companies to increase executive perks, on the ground that the tax collector would get the money if it weren’t spent on limousines and Lear jets.

It will be noticed that the foregoing probabilities are to some degree contradictory. It is something of a paradox that lower personal and higher corporate taxes can be expected to result in both higher executive salaries and perks as well as higher winnings from speculating in the securities of the companies whose earnings are reduced by paying the salaries and perks.

This can happen all at once through an accentuation of the polarization of the American economy. The rich can become richer by keeping the poor in their place and by pushing more of the middle class down to join them. The trend can continue for a damnably long time without arousing much political reaction. The possibility of an economic reaction is more immediate. As Jean Baptiste Say, in one of his acuter moments, wrote, “There is nothing to be got by dealing with people who have nothing to pay.”

Our economy is bad because our morale is bad. For too many years, greed has been admired in high places and doing good has been sneered at. A steeply progressive income tax would be a sign of a shift in morale-which would be far more important than whatever increased revenue might be raised, and vastly more important than the size of the deficit.

The New Leader

[1] Readers with a bent for trivia may recall that one of the targets of Major Kong’s B-52 in the movie “Dr. Strangelove” was Laputa. According to IMDb, “Major Kong’s plane’s primary target, is an ICBM complex at Laputa. In Jonathan Swift‘s 1726 novel ‘Gulliver’s Travels’, Laputa is a place inhabited by caricatures of scientific researchers.”

In all the current talk, business ethics has come in for special attention, and many an editorial has proposed required ethics courses in business schools. Lester C. Thurow, the new dean of MIT’s Sloan School of Management, resists the idea on the ground that the blight, if any, goes much too deep to be reached by a tacked-on series of lectures or bull sessions. Morals, he says, should have been learned at home and in the community long before graduate school. I resist the special course idea, too, but on the ground that if students have been learning bad ethics or no ethics, it is because they have been taught bad economics.

Economics used to be called an ethical science, an expression that resonates oddly in our ears. Come to think of it, our term, “social science,” gives off similar vibrations. Social relations surely have an ethical aspect (if it exists at all), while the propositions of the natural sciences (what we think of as proper science) do not. There is nothing moral or immoral about the solar system, or about the way electrons bond, or even about AIDS. Morals may be – most often certainly are – involved in the transmission of AIDS, but the physiology of the disease is neither right nor wrong. Indeed, it is only because the disease is a natural phenomenon that there is any hope of containing or curing it. Even the calls for sexual abstinence must depend on the fact that the disease obeys natural laws and is neither a random accident nor a supernatural visitation.

“Nature to be controlled,” as Francis Bacon said, “must be obeyed.” Thus disease control (which is a human end) uses medicines (which are natural means). Thus engineers use the principles of physics to achieve their ends. The ends are not natural, but the means are. It is frequently argued that economics presents a parallel situation. In 1874, Leon Walras, in his Elements of Pure Economics, distinguished at considerable length between economics as an ethical science, which considered what ought to be done; economics as an art, which taught how to do it; and economics as pure science, which described how it worked. Toward the close of the century, a similar tripartite analysis was made by John Neville Keynes (John Maynard’s father). In our day, Milton Friedman, perhaps indulging a puckish humor, has quoted favorably from the senior Keynes’ work.

The parallel between physiology or physics on the one hand and pure economics on the other is, however, false. There is no such thing as pure economics. Physiology and physics can be studied – must be studied – without regard to the willful act of any individual or group of individuals. But no antiseptic event of that kind occurs in economics. Walras, whose work was hailed by Joseph Schumpeter as “the only work of an economist that will stand comparison with the achievements of theoretical physics,” opened his analysis, after a long introduction, with the observation, “Value in exchange, when left to itself, arises spontaneously in the market as the result of competition.” But this pure proposition is immediately corrupted by willful humanity: “As buyers, traders make their demands by outbidding each other. As sellers, traders make their offers by underbidding each other.” (Walras’ emphases.)

Without those traders making their demands and offers, there is no economics, pure or applied. With those traders, economics becomes inextricably immersed in questions of morals. I do not mean merely that trade is impossible unless traders abjure fraud (at least up to a point), although certainly this is true. What I mean is that demands and offers – the fundamental elements of “pure” economics – are not acts of God or events of nature but acts of human beings who necessarily define themselves by what they do, including what they do in the marketplace. Perhaps more to the point: Demands and offers can be understood only as acts of will.

There has been no lack of attempts to develop other explanations, and they form the division of economics known as “value theory.” Prices are determined by the reconciliation of demands and offers, and demands and offers are said to be determined by values. There are three leading explanations of value. The first, found prominently in Adam Smith and Karl Marx, holds that things become valuable commodities in accordance with the amount of labor that goes into their production. The second, advanced by Jeremy Bentham, argues that only useful things are valuable, and that utility derives from the promotion of pleasure or the avoidance of pain. The third, credited by Leon Walras to his father Auguste, founds value on rareté, a combination of scarcity and utility.

All these explanations turn out to have exceptions. The labor theory cannot explain why a house in the Houston suburbs that sold for a quarter of a million dollars only yesterday can be bought for half that price today and will sell for a different price tomorrow. The utility theory cannot explain why proprietary drugs are more expensive than their generic equivalents. The simple scarcity theory cannot explain why gem-quality diamonds are more expensive than bluebird nests. Put them all together in the rareté theory, and you still can’t explain why baseball stars are paid in the millions of dollars and croquet experts have to pay to enter tournaments.

Of course, the problem of the exceptions has not gone unnoticed. The typical solution turns on a relaxed definition of utility. Proprietary drugs, for example, may be said to be more useful to some people because they carry an implicit guarantee of quality and so enhance satisfaction and pleasure or suppress apprehension and pain. The greater perceived utility naturally results in a higher price.

But see what has happened. The utility theory, like all the theories, was introduced to provide an objective foundation to value. Bentham intended his “felicific calculus” to be the equivalent of Newton’s laws of motion. In reality, though, it is highly subjective. Some people are pleased by drugs’ brand names and some are pained by the higher prices. Bentham himself summed up the situation in an aphorism: “Quantity of pleasure being equal, pushpin is as good as poetry.” One man’s pleasure is another man’s pain. Utility is what each individual says it is; it has none of the universality of gravity.

IRONICALL Y, the consequence was noted by William Stanley Jevons, a leader in developing Bentham’s utilitarianism into the modern quasi mathematical theory of marginal utility. Calling for increased efforts to collect economic statistics, he wrote, “The price of a commodity is the only test we have of the utility of the commodity to the purchaser …. ” And, he might have added, of its utility to the seller, too. Price may be explained by utility, but all we know of utility is price.

The other value theories are no less circular. Marx, recognizing that a lot of labor can go into producing positively harmful commodities, avers that “socially useful” labor makes value. So it is not labor that is the test of value; it is value that is the test of labor. The tree is known by his fruit. Walras’ rareté also leans on the weak reed of utility, as well as on scarcity.

The only way to keep a circular argument from chasing its tail is not to let the chase get started. Let us, therefore, return to the men and women who did the price-paying of Jevons, the offering and demanding of Walras, and the laboring and social evaluating of Marx. Who are these essential people? As Pogo might say, we have met them, and they are us.

The various value theories we have mentioned each try to make us into passive agents controlled by the economic counterpart of nature. Even perfect competition (the state imagined to provide perfect liberty) requires everyone to be what is called a “price taker.” Prices are then said to be made by the market.

Those who quarrel with the idea of perfect competition tend to do so on the ground that competition never is and never has been perfect. That is true enough, but the reason for this is that the notion of an impersonal market that sets prices is a pathetic fallacy.

Farmers are the standard textbook examples of price takers, unable to influence the price of what they sell, whether they produce more or less, and whether they sell now, or later, or never. Yet if all producers and all consumers – that is, all human beings – are price takers, where do prices come from? Only cynics claim that the individual voter is insignificant because he or she is merely one among tens of millions. The republic will not collapse if I fail to vote; it will collapse if no one votes. It is the same with economic agents. Someone has to set a price, or there is no price system and no economics. An economy of passive agents is a contradiction in terms.

Economics is one of the modes of ethics. Pure economics – economics without people and hence without ethics – is a myth. Morality can’t somehow be tacked onto economic affairs, which otherwise are amoral. Ethics is there at the beginning, or it is not there at all. It is always there because there is no economics that does not concern human acts, and all human acts are acts of will. What is true of economics, the theory of business enterprise, is obviously true of business itself. Business ethics is not merely the proposition that honesty is the best policy. The ethical question, in business and everywhere, is, What sort of person am I? There is no escaping it. That question is posed by everything I do.

Interestingly, Keynes presented his argument in a mixed form-half definition and half equation. As it now appears in the textbooks, it looks like this: (l) Y = C+ I; (2) Y = C+ S; therefore (3) S= I. But Keynes used only the operational symbols (=, +, -), relying on English for the rest of what he had to say.

Was the mixed language meant to warn against use of the argument as an ordinary equation? Since Keynes didn’t make the point explicitly (and he wasn’t usually bashful), I may be reading too much into his text. Nevertheless, he did not use it as an ordinary equation himself; he noted that “Saving, in fact, is a mere residual”; and he ended the chapter by declaring, “the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

So-called Keynesians disregard the implicit warning and proceed to manipulate S = I as they would any equation. These people, whom Joan Robinson called “bastard Keynesians,” make up the majority of American and British economists today. When President Nixon said, “We are all Keynesians,” he should have said, “We are all bastard Keynesians.”

Indeed, if S = I is a statement about residuals, you can’t increase the value of Y, in equation (2) above, by increasing the value of S. Income or production is necessary to saving, but not the other way around. An ordinary equation, though, knows nothing of residuals. If Y = C + S is treated as such, you can increase Y (production) by increasing S (saving); and this has been a steady objective of national policy from President Kennedy on down to President Reagan.

For 30 years now, we have been bombarded with appeals to save, with inducements to save, with threats of disaster if we don’t save. To help us save, every Administration, Democratic and Republican, has cut taxes one way or another. Industry has been offered inducements to invest (S = I); business’ share of Federal taxes has been reduced from 28.6 per cent under Presidents Roosevelt and Truman to less than 6 per cent at present; the top personal income tax has been slashed from 85 per cent to next year’s 28 per cent; and starting with California’s Proposition 13, many states and municipalities have followed in the train. Yet our savings rate has steadily fallen and is currently at an all-time low.

Now, what has been done (and is still being done) is perfectly congruent with traditional (that is, pre-Keynes) economic thought. Traditionally, one observes that every new company is in business for weeks or months or even years before it has anything to sell, let alone any profit. All the while it is paying wages, otherwise the workers would starve. The entrepreneur has to have saved money to pay the wages; and farmers have to have stored (saved) food for the workers to buy. Either that, or everyone else’s rations have to be cut. Furthermore, the new company has to build a factory, and the materials going into it can’t also be used by someone else to build houses. So again the entrepreneur has to have saved money, and again primary suppliers have to have stockpiled (saved) materials, or have to deny them to other users.

The traditional story makes perfect sense – provided you forget that the modern economy runs on credit and is dynamic, not static. An entrepreneur may have saved a little money, but he borrows most of what he needs from banks, which have assembled the relatively small savings of a lot of people. Without those savings, according to the traditional story, the banks would have nothing to lend to entrepreneurs.

That, too, seems reasonable – until you remember how fractional-reserve banking works. Banks don’t lend merely the sum of the deposited savings but perhaps 10 times as much. That is, they retain a reserve equal to 10 per cent of their loans. Whatever the reserve, it is not an immutable figure; it is set either by the banks’ directors or by some governmental authority; it can be changed down or up, anywhere from zero to 100 per cent, or even more. It is a question of credit, belief, trust, faith, determination.

Let’s take the extreme case of zero reserve. An entrepreneur, who has no money, goes to a banker, who has no money. The banker says, “I like the cut of your jib, and I believe you have a good project. I’ll credit your account with x dollars, which you’ll eventually repay plus y per cent interest.” The entrepreneur draws checks on this account, and these are accepted by employees and suppliers, because they believe the bank exercises good judgment in making loans. The suppliers and workers deposit their checks and draw on them to pay their creditors, and the process continues ad infinitum. Maybe somewhere along the line a few people will want greenbacks or coins, and these can be purchased with a check. The whole edifice is built on faith. Even the greenbacks and coins are articles of faith. How else is a hundred-dollar bill worth more than a one dollar bill?

So a company has been created out of nothing, and sooner or later the banker gets back the money that he didn’t have in the first place, plus interest. It may seem outrageous – not to say incredible – that the banking system could do all this without any savings whatever. Yet a zero reserve is scarcely less credible than a 10 per cent reserve, or than a 90 per cent reserve. As far as an entrepreneur’s need for money is concerned, no one has to have saved anything at all. It is, to repeat, entirely a question of the expansion of credit and credibility.

Nor, in a modern economy, need any special measures be taken to ensure that the workers have food and that the factory builder has materials. One way or another, everyone in a civilized society will have food to eat whether there are jobs or not; no farmer plants an extra row of beans just because someone gets a job. Likewise, steel makers and brick manufacturers organize their output in as steady a flow as they can manage.

Primary suppliers and their bankers have faith that the economy will advance at a certain rate, and the rate includes the actions and the needs of entrepreneurs.

In sum, no one has to save money, and no one has to save things. Saving is a mere residual. Consequently, all the palaver we’ve listened to about saving for the past quarter century is beside the point. Worse than that: It has caused grave distortions of the economy.

First, there is the question of what happened to all the tax reductions that were made to encourage saving. The saving wasn’t needed; so it didn’t occur. Yet the tax reductions did occur, as the deficit is our witness. Where did the money go? A good bit of it went into consumption; that’s what fueled the so called recovery. The lion’s share, however, has gone into speculation. The stock market boom has been paid for partly with tax dollars, partly with the borrowings of speculators (for banks lend the same sort of money to speculators as they do to producers), and partly with the trade deficit, whereby others (mainly Japanese, Germans and Taiwanese) have traded their goods for shares in our industries and infrastructure.

Second, there is the question of how the tax reductions were distributed. Like traditional economies, bastard Keynesianism reasons that in order to expand production, you have to expand saving, and therefore you must get more money into the hands of savers. Who are the savers? Those who don’t need the money, of course. Those who need money obviously will spend it; they can’t afford to save. So the tax breaks, in a steady stream, have gone to the rich. The poor, especially, the way it happens, the working poor, have got the short end of the stick. Even those properly dropped from the 1987 tax rolls are merely the people who had been improperly added to the rolls back in 1981.

AS NOTED, the so-called recovery (Y) has been fueled by consumption (C). Neither Y nor C is a residual, for production and consumption are implicit in the simplest economy – in life itself. If consumption were greater, the recovery would be greater. Consumption would be greater if tax benefits went to the poor, who would spend them, rather than to the rich, who pour them into speculation. Reaganomics has not only rewarded the rich for being rich and punished the poor for being poor; its transmogrification of greed from a deadly sin to a virtue has so skewed the rewards and opportunities of our economy that one fifth of our people and one-fifth of our industrial capacity are either underutilized or not utilized at all.

Well, Reaganomics is not to blame for all our troubles; it has merely aggravated them geometrically. The time is out of joint and will not easily be set right. As I have said several times in this space, some sort of employee ownership will be necessary. I say “some sort” because many proposals have been made. The sad truth is that they are scarcely noticed either by those who claim to be experts or by the general public. Characteristically, the standard book review media don’t pay attention to proposals that are made in book form. I don’t find this aloofness a point in their favor.

I have a reservation about the ESOP law as it is currently drawn and several more about extensions proposed in the Kelsos’ new book, but they’re relatively unimportant. The Kelsos’ is the only game in town that is actually being played. What they have done and what they propose are of the utmost importance to the general welfare. Theirs are books that every good citizen should read and ponder.

The New Leader

Share this:

Like this:

A COUPLE OF years ago, Mayor Edward I. Koch was asked who was responsible for pulling New York City back from the brink of bankruptcy. In one of his formerly frequent bright moments, he replied. “Well, I suppose someone has to get the credit, and it might as well be me.”

But they don’t deserve all the credit. They should share it with Paul A. Volcker, for they couldn’t have raised the interest rate to usurious heights without his help. That may not be a nice thing to say about a man who is now retiring from government after many years of undoubtedly self-sacrificing service. Unhappily; I have some even less nice things to say. I say them not only in sorrow but also in anger, because people have been hurt-have had their lives ruined-by the lordly mistakes of this big man, and because his smaller successor as chairman of the Federal Reserve Board, Alan Greenspan, is apparently ready to keep making most of the same mistakes (besides, when the wind is north-northwest, declaring his devotion to Ayn Rand and longing for the gold standard).

Let’s briefly examine the Volcker record in five areas- (1) inflation, (2) general welfare, (3) economic output, (4) foreign trade, and (5) the deficit and then look more closely at his underlying theory. Volcker is admittedly not single-handedly responsible for the bad things-or the good things, if any-that can be pointed to in each case. He had a lot of help from Ronald Reagan, from legions of people who were sure they were doing what the President would have wanted had he been paying attention, and -yes- from you and me. Nevertheless, even if Paul VoIcker wasn’t, as the commentators liked to say, the second most powerful man in the world, he is, as they also say, a legend in his own time. It’s really what he stands for that I will [be] talking about.

1. Inflation. There is no doubt that VoIcker’s present fame is based on his claim to have been the tamer of the inflation dragon. He took office at the Fed in October 1979 and immediately began his attack. What really happened? From that December through December 1986, the Consumer Price Index (CPI) rose 51.06 per cent in constant dollars. In comparison, the increase from 1972 through 1979 was considerably greater, 73.50 per cent, but from 1964 through 1972 it was considerably less, 34.88 per cent. And if we go back to the bad old days of Harry S. Truman, we find that the increase from 1948 (following the jump when wartime controls were suddenly ended) through 1952 was only 10.26 per cent. On the record, VoIcker, the great inflation tamer, turns out not to have been all that great.

2. General Welfare. VoIcker never made a secret of the fact that his program was going to hurt. That may have been, as Ring Lardner would have said, one of its charms. Again using constant dollars, we find that from 1964 through 1972 the median family income increased 25.46 per cent; from 1972 through 1979 it increased 1.56 per cent; but in the VoIcker years, from 1979 through 1985 (the latest Economic Report of the Presidentdoesn’t have 1986 figures for this), the median income fell 4.56 per cent. Given that more families had multiple wage earners in 1985 than earlier, the drop in family income was even steeper.

The fate of the poor was much more dramatic. The number of our fellow Americans living in poverty actually declined 32.13 per cent from 1964 through 1972; it held unchanged from 1972 through 1979; but it jumped 26.81 per cent in the Volcker years.

On October 19, 1979, shortly after taking office, Volcker proclaimed, “The standard of living of the average American has to decline.” He made it happen.

3. Economic Output. Volcker’s rationale for hurting people was that inflation would thus be controlled, and the rationale for controlling inflation was that prosperity depended on it. As we have seen, inflation was only slightly restrained; perhaps it will be said that is why the recovery has been so lackluster.

The GNP rose (in constant dollars) 32.19 per cent from 1960 through 1972; 22.38 percent from 1972 through 1979; and only 12.30 per cent in the Volcker years. Since the working-age population increased 8.19 per cent in the last period, and more people produce and consume more goods, the Volcker recovery has been overpraised.

4. Foreign Trade. Everyone knows that our recent performance in foreign trade has been abysmal. If the monthly deficit on current accounts falls a point or two, it is hailed as a triumph. Everyone knows, too, that the strong dollar of recent years has made it difficult for American industry to compete either at home or abroad. What few remember, however, is that the strong dollar was a deliberate objective of Volcker’s policy, announced as early as October 17, 1979. It was supposed to stabilize international trade, and it sure made it fun to travel in Europe and to buy Volvos and Mazdas and madras shirts in the U.S. All this naturally contributed to the trade deficit and put Americans out of work. It also made it easier to sell American bonds-not goods but bonds-abroad. Volcker wanted the strong dollar because it made it easier to finance the American deficit-again a way to achieve a questionable result by imposing unquestionable hardship on millions of people.

5. The Deficit. The deficit question is a phony, and so is the problem of financing it; and I don’t mean merely that it wouldn’t have seemed important if it hadn’t been for the Kemp- Roth tax cuts. Volcker certainly isn’t to blame for those. He is to blame, though, for crying wolf over the deficit.

There are a few ways a national debt is like a personal debt, and one of them is that the amount of debt a nation can bear is a function of its income. Poor people and poor countries have trouble with small debts; rich people and rich countries can carry big debts. The United States’ debt is always thought enormous by knee-jerk conservatives; this was one of Reagan’s arguments against Jimmy Carter. In 1979 the Federal debt held by the public (some of it, of course, is held by government agencies, mainly Social Security) was 26.33 per cent of GNP. That was one of the lowest ratios in years, but Reagan promised to wipe it out and Volcker strengthened the dollar to help him. By 1986 the debt had risen to 41.94 per cent of GNP. This is a lot hairier than the 1979 animal, but even so it’s not a real wolf.

For something like a real wolf, we can go back to 1946, the last year of World War II, when the Federal debt held by the public was 113.62 per cent of GNP. If there is validity to the notion that a high debt/GNP ratio induces or requires a high interest rate, the 1946 rate should have been wild. Yet in that year, three-month Treasury bills paid all of three-eighths of 1 per cent, and the prime was 1.5 per cent.

Now consider this: During the Volcker years the Federal debt held by the public increased by $1,102 billion, and the interest paid on that debt amounted to $844 billion. Suppose the 1946 rate had been paid instead of the Volcker rate. The interest bill would have been reduced by about $812 billion, while the debt itself would have increased only $290 billion. At the same time, the debt/GNP ratio would have fallen to 2.46 per cent-hardly anything to get excited about (except as probably too low), and certainly below the urgent need for foreigners to invest in our bonds.

It comes down to this: Volcker allowed interest rates to soar, partly to reduce the average American’s standard of living, and partly to encourage foreign investment in government bonds. He was successful on both counts. But if the rates had been lower, the deficit would have been minuscule, and the foreign investors wouldn’t have been needed. High interest rates simply gave a lot of money to rich foreigners-and to rich Americans, too.

I HAVE ALREADY said that Volcker’s attack on the inflation dragon was not outstanding. I now make the heretical claim that his maneuvers with the interest rates indeed caused inflation to be greater than it might have been.

First, let me make a minor observation. The inflation rate is not a figure you read off an instrument, like barometric pressure. It is a statistical construction, and one of its factors is the interest rate. Consequently, interest rates and inflation rates have a tendency to go up and down together. This is an arbitrary and possibly small effect, and one that could be eliminated by slight pressure on a computer key; nonetheless, it stands as a real fact in the real world.

Second, let me make the much more important observation that speculation is vastly stimulated by volatile interest rates. Volcker says that if the strong dollar weren’t available to bring in foreign money, Federal borrowing would crowd producers out of the money market. But speculation can always crowd out production, and that is what Volcker’s policy has encouraged.

There is a still more serious effect than either of these. If you are running a business and your friendly banker says he wants 20 per cent to renew your 10 per cent loan, your first defense is to increase your prices. Moreover, the loan isn’t the only thing that bothers you, because what economists call the “opportunity cost” of the money you and others have invested in your business increases as well. That is, whoever invests in your business passes up the opportunity to make easy money by being a lender rather than a borrower; so you have to raise prices to take care of that, too, and keep your colleagues from wanting to sell out.

A significant aspect of these increases is that they are percentages. What’s more, similar percentage increases are being made by everyone who supplies you with raw materials or rents you office space or provides shipping services for you. Every company below you in the production chain is adding a percentage to its prices, and you add your percentage on top of their inflated prices, and the companies above you in the chain do the same. The result is that, as Adam Smith observed in a little-noticed passage, prices are increased geometrically, whereas a wage increases pushes up prices only arithmetically.

The immediate impact of an increase in interest rates, therefore, is an increase in inflation. Of course, the intended decrease in the level of business follows sooner or later (it took Volcker almost three years to get things down to where he wanted them). Sooner or later, people can’t afford the new prices. Businesses can’t sell as much as they used to. Workers get laid off. Unions get afraid to strike. Wages are held down, and so price increases can be relaxed. This is what Volcker frankly worked for. But true to Adam Smith, we see that when wages go down (empirically, when any cost-including interest-goes down), prices fall only arithmetically; and if interest rates remain high, the net pressure on prices will continue to be upward.

Even a very severe depression (and Volcker made us one) will at best slow inflation; it will not stop it as long as interest rates remain high.

Volcker’s announced policy was to control the money supply (Ml) and let the interest rate take care of itself.

His theory was that a controlled money supply would raise the interest rate, and that a drop in the inflation rate would take place. He was never able to keep M1 growth within the guidelines advocated by Milton Friedman. It’s just as well.

As the table above shows, in 1981 a minor fall in Ml growth (one of only two such occurrences in Volcker’s career) was accompanied, not by a rise, but by the second largest fall in the prime rate, and followed by the largest fall in the CPI. On the other hand, in 1985 the biggest jump in Ml was accompanied by a substantial fall in the prime and followed by the most dramatic fall in the CPI. In general, the figures in the table can be made to support Volcker’s theory only by appeals to “lags” and “anticipations” and other statistical gyrations of the sort J .B. Rhine used to “prove” extrasensory perception. For true believers in the Volcker magic, when 1980’s slight tightening of the money supply was followed by a slightly lower inflation rate, that “proved” the theory. But when 1984’s greater tightening was followed by an increased inflation rate, that “proved” businessmen had expected the tightening and had moved to offset it. Either way, Volcker’s theory was a winner. But such pseudo-logic can equally “prove” the opposite.

In short, there is no way on earth to construct a valid correlation of changes in the money supply, interest rates and inflation rates that will support Volcker’s theory of what he was doing. And there is no way on earth to deny that what he did reduced the standard of living of average Americans and forced millions more into poverty. The theory that I (and Adam Smith) have advanced (for a somewhat fuller exposition, see my note in the Winter 1986-87 Journal of Post Keynesian Economics) goes at least part way in showing why Volcker’s theory was wrong.

A case can be made for many Volcker virtues, especially in impeding somewhat the rush to deregulate banking. But the false legend of big Paul Volcker and the dragon is one that shouldn’t be told to children-or to grown-ups, either.